The Daily - Apple’s Bet on China

Episode Date: June 14, 2021

Apple built the world’s most valuable business by figuring out how to make China work for Apple.A New York Times investigation has found that the dynamic has now changed. China has figured out how to make Apple work for China.Guest: Jack Nicas, who covers technology from San Francisco for The New York Times. He is one of the reporters behind the investigation into Apple’s compromises in China.Sign up here to get The Daily in your inbox each morning. And for an exclusive look at how the biggest stories on our show come together, subscribe to our newsletter. Background reading: An investigation from The New York Times offers an extensive inside look at how Apple has given in to escalating demands from the Chinese authorities.One of the compromises Apple made to China was storing its Chinese customers’ data on servers controlled by the Chinese government. Here are four more takeaways from the report.In the United States, data requests have placed Apple and other tech giants in an uncomfortable position between law enforcement, the courts and the customers whose privacy they have promised to protect.For more information on today’s episode, visit nytimes.com/thedaily. Transcripts of each episode will be made available by the next workday. 

From The New York Times, I'm Michael Barbaro. This is The Daily. Today. Apple built the world's most valuable business by figuring out how to make China work for Apple. But a Times investigation has found that that dynamic has now changed and that China has figured out how to make Apple work for China. Sabrina Tavernisi spoke with one of the reporters behind that investigation, Jack Nickus.

It's Monday, June 14th. Jack, tell me how you got into this story about Apple's relationship with China. Sure. So I started covering Apple for The Times in early 2018, when Apple was really starting to push its stance on privacy. It was becoming a main selling point for Apple. This is when Facebook was facing a lot of scandal about how it was handling user data, and Apple saw that as an opportunity to differentiate itself from its rivals. We even see Tim Cook, you know, Apple's CEO, in interviews saying privacy is a fundamental human right. You know, this is like freedom of speech and freedom of the press.

And privacy is right up there for us. And so we've always done this. Apple was making its pitch to consumers that they can trust their data with Apple. Now, what was interesting about Apple's push with privacy was I knew that Apple was deeply embedded in China. Apple was manufacturing virtually every Apple device in China, and it was selling $47 billion a year there, its number two market after the United States. And at the same time, China is ramping up its surveillance and also its censorship operation and was not a country that cared a lot about privacy. And so I was interested to understand how Apple was reconciling its focus on privacy with the reality that it was so deeply embedded in China.

Okay, let's start there. How did Apple become so deeply embedded in China in the first place? Well, I think we have to go back to the late 1990s. Apple Computer, a pioneer in the personal computers and software business, has fallen on hard times. It decided to lay off 1,300 workers. This may be surprising to some listeners, but Apple was actually on the brink of bankruptcy at that time. to some listeners, but Apple was actually on the brink of bankruptcy at that time. Apple once promised a computer for everyone, but now the standard computer is not a Mac, but a PC.

And to save the company. Apple Computer has named Steve Jobs its interim chief executive officer. The board of directors brought back Steve Jobs, their co-founder. And over the next several years... This is iMac. The whole thing is translucent. You can see into it. It's so cool. Steve Jobs oversaw a few hit products. There was this colorful iMac. Looks like it's from another planet. A planet with better designers. How many times have you gone on the road with a CD player and said, oh God, the CD, I didn't bring the CD I want to listen to. And then there was the iPod. To have your whole

music library with you at all times is a quantum leap in listening to music. Now, Apple was still actually manufacturing products in the United States. But Tim Cook, who was the chief operating officer at the time, realized that it wasn't really sustainable because of high labor costs. And also, there wasn't just a lot of other factories and suppliers in the United States. So there wasn't this condensed supply chain. So Apple was starting to move to Asia. It was manufacturing in Japan and Taiwan and Korea.

And then in 2001, something really interesting on the global stage happened. By adding China to the WTO, we strengthened the organization. The World Trade Organization and all of its countries, including the United States, admitted China as a member. China is not simply agreeing to import more of our products. It is agreeing to import one of democracy's most cherished values, economic freedom. In previous years, China and the communist government had this state-run, tightly controlled economy. And there were a lot of obstacles to do business there. The WTO agreement will move China in the right direction.

It will advance the goals America has worked for in China for the past three decades. And of course, it will advance our own economic interests. And so what was really important about China joining the WTO was that it meant that China now had to abide by these international standards for manufacturing and trade, and the Chinese government had to be a little bit more hands-off toward private companies. And so Apple decided to try to test the waters there. So China joined the WTO, which meant a company like Apple would have more protections operating there. But why did Apple decide to go to China as opposed to expanding, say, in Korea or Japan or Taiwan, where it was already manufacturing stuff? Well, Apple was suddenly growing very rapidly.

The iPod had become a smash hit, and it started to realize that it was going to need more space and more labor to keep up with demand. And so China especially was appealing because it obviously had an enormous labor force. There was very rapidly a supply chain that was building out there with many different suppliers already based there, which made manufacturing products easy. And the Chinese government, crucially, was pouring literally billions of dollars into infrastructure and factories to build out the supply chain and really make it easy for companies like Apple to come in and make these rather advanced products there. And when you say build out the supply chain, what exactly does that mean?

What's the government doing? Sure, we're talking about paving roads, you know, sometimes right through villages, building power plants, building employee housing, building factories. Let me give you an example that I think best illustrates this. So one of my sources was a former senior Apple executive, and he told me about a story in 2004 when Apple was trying to build a large iPod factory in China. And when he visited the site with a partner in China, they were looking around and he wanted to know where they were going to build the factory. And the partner said, right here. And the problem was there was a small mountain in the place where the

factory was supposed to be. And he was confused. He said, this factory is supposed to be built in six to seven months. There's a mountain there. And the partner said, just trust us. So six to seven months, there's a mountain there. And the partner said, just trust us. So six to seven months later, you know, my source returned to China and he was astonished to see that the mountain was essentially gone. And there was indeed an iPod factory there, almost up and running and employees getting in there. And that was a show of the Chinese government's might and its investment and its ability to attract a company like Apple. So China is quite literally willing to move mountains for this company. Totally. I mean, this really illustrated to Apple that China was where it wanted to be. So Apple made a bet on

China. And the bet was that China would not only be a great place to do business in the short term, but that the Chinese government and China itself would be a great business partner and not put restrictions on how Apple did business over the long term. And there was no reason to really think otherwise. China had really been moving in just one direction. The place was opening up economically. And there was a belief among many economists and politicians and business leaders in the Western world that the more Western companies poured money into China, the more China would economically open up, the more it would politically liberalize, and the more China would resemble the Western world. Okay, so this bet that Apple makes on China in 2004, how quickly does it start to pay off? Basically immediately. It was pretty clear from the early days of the iPod in China that China was going to be able

to handle that business. And they made a decision that would actually prove to be far more consequential down the road, and that was to build their next product there. Today, Apple is going to reinvent the phone. And we are calling it iPhone. Now, the iPhone launched in 2007, and... There's always hype surrounding new gadgets from Apple. But this is an all-new level. You know, pretty quickly, it was a hit product.

People have even waited in line for several days. I've got food here, water's here, some snacks. What about sleeping? Sleeping? I sleep right here on my chair. In those first few years, the iPhone doubled in sales and doubled in sales and doubled in sales, and China was keeping up. Really, Apple is the story.

Better than expected earnings. Profits up 47 percent. Strong iPhone sales. Strong max. And also in 2009, Apple began selling iPhones in China. And that is a huge consumer market. Absolutely. And I think Apple saw that from the early days, that this was one reason to get into China.

I think the upside over the next couple of quarters is all going to be driven by the iPhone, and most notably China, the ramp of China. That's going to be a huge opportunity for them. So by this time, 2009, things are going really great. But there were also some warning signs. In 2009, China actually blocked Twitter and Facebook. In 2009, China actually blocked Twitter and Facebook. And the following year, China was caught hacking Google and also was trying to censor Google search results. And so Google very abruptly pulled out of the country. And so at that moment, many of the tech companies were either being blocked or were fleeing China. So these moves by the Chinese government seem like signs that, okay, China may be opening up economically,

but politically, the country was not liberalizing. Right. But Apple, meanwhile, was really doubling down and becoming more entrenched in the country. iPhone sales are skyrocketing. Apple's now selling in China, which is helping that. And to keep up, Apple and China are building bigger and bigger factories. And Apple's dominance continues. The company announced it sold more than 2 million iPads in less than two months.

Apple again decides to build its next new product, the iPad, in China. Then in 2011, the Tim Cook era begins at Apple. Tim Cook, who really was the mastermind of Apple's entrance into China, is rewarded with the job of CEO after Steve Jobs becomes sick and eventually dies. And then finally, as the biggest affirmation and the biggest evidence of the success of Apple's bet on China. Apple is now the most valuable company on the face of the planet. Apple becomes the world's most valuable company, surpassing ExxonMobil. Yep, it was all because of the iPhone and the iPad, Andrew. These two gadgets... At this point, Apple is really on top of the world.

And that never would have been possible without China. But shortly after that, China starts to change the terms of its relationship with Apple. And things become a lot more complicated. We'll be right back. So Jack, you were talking about changes happening in China that really kind of changed the terms of the bet Apple was making. What were those changes? Right. Well, it really has to do with the leadership of the Chinese Communist Party. So in 2013, there is a change in government and a new president

assumes power, Xi Jinping. And he has a very different style than his predecessors. And from that day on, the relationship between Apple and China fundamentally changed. How so? Well, I can actually just start with literally the first week of the presidency. So he assumes power on March 14th, 2013. And the very next day, Apple was under attack. China Central Television, which was the main government broadcaster, aired a report criticizing Apple.

And basically they were saying that Apple doesn't issue long enough warranties for its products. The implication was that Apple was ripping off Chinese consumers. Why do Chinese consumers lose one percent? This is too unfair to Chinese consumers. And very quickly, there was this coordinated criticism of the company across Chinese society. The Chinese state-owned newspapers were calling Apple a quote-unquote scoundrel. Chinese celebrities were all criticizing the company on social media. And it was really clear that this was a sign on just the second day of Xi Jinping's administration

that the Chinese government was taking a different tact with Apple. But why? Why would Xi Jinping and the Communist Party decide to attack Apple so suddenly after this incredibly successful and profitable relationship they'd cultivated for more than a decade? Well, it's because Xi Jinping had very different plans for China. He comes to the presidency with a belief that China must regain its position as the most powerful economic and military force in the world. And to do that, she was trying to reduce China's dependence and go after the Western companies like Apple that had really been amassing a lot

of influence in the country and really lift up some of the homegrown tech companies like Baidu and Tencent and Alibaba. And a big reason why China was changing its approach was because China could. China suddenly had a lot more leverage and it had a lot more economic power, in part because of the investment from Apple and other Western companies. You know, by 2013, China was the world's number two economy. And that is a very different place than it was in 2001. And it meant that Xi Jinping had more power and more ability to get his way. So how does Apple respond to this attack by Xi Jinping? Well, Apple trying to save face

in one of its fastest growing markets. Within several weeks, Tim Cook took a really unusual step. An unexpected apology this morning from Apple to the Chinese people. He issued an open letter and he apologized. Tim Cook saying, quote, we recognize that we have much to learn about operating and communicating in China. And said that Apple had, quote, incomparable respect for China and that Apple had a lot to learn about operating in the country.

A humbler Apple, if that's possible here. And it was a real sign that the dynamics of this relationship had fundamentally changed. So did this new stance from the Chinese government ring any alarm bells inside the company? Yes. Pretty quickly, there were these conversations inside of Apple about the dilemma that they faced in China. And specifically,

there was this former Apple employee who was a senior advisor in China. And he told me that early on, he realized the predicament Apple was in, and he tried to get the company's leadership to do something about it. And so he was able to get an audience with some of Tim Cook's top deputies and make the case that Apple had basically no plan B to China. And that really left the company vulnerable to the whims of the government. But ultimately, nothing really changed at Apple.

And that was in part because there was really no other country that could support the type of manufacturing that Apple now required. And there was certainly no consumer market that could make up for the lost sales if Apple had to leave China. So Apple was stuck. Exactly.

So how does this new chapter of the relationship between Apple and China play out? Well, for Apple, you know, from a business standpoint, things continue to go wonderfully. Apple's valuation is skyrocketing. People continue to not be able to get enough of its products. But its situation in China is continuing to get hairier. And that's in part because over the next several years, we're starting to see that the administration of Xi Jinping is an increasingly authoritarian one. Xi's government is building out a nationwide video surveillance network.

They are getting more access to the data of China's biggest internet companies like Tencent. And they are starting to become much stricter internet sensors and cracking down more and more on what people can say and read on the internet. And that was a worrying sign for Apple. You know, as the iPhone began to sell more and more in China, Apple was increasingly a gateway to the internet for Chinese citizens. And then in the summer of 2017, the new law was approved by China's National People's Congress. This new Chinese cybersecurity law went into effect. That was a big deal for Apple. China says it's necessary to safeguard cybersecurity

and protect against hackers from within and outside. And what exactly is this new cybersecurity law in China? So the law requires tech companies to store data that is created in China in China. So the law requires tech companies to store data that is created in China, in China. Companies in key industries will need to open up their computer systems for security examinations. Most of their data will need to be stored locally and crime investigations will have access to that data. And that's bad news for Apple because of iCloud. Now, iCloud is Apple's data storage service that millions of Chinese consumers use to store personal private data like their contacts, documents, photos, emails, even their real-time locations. Prior to this law, Apple stored this

data largely outside of China. And this data was encrypted, which meant it could only be accessed with certain digital encryption keys. And Apple kept those digital keys to unlock the data outside of China as well. Under the new law, China wants Apple to bring that data to China and store that data on Chinese government servers. And it also wants Apple to bring the digital keys to those servers as well. So China wants Apple to store its Chinese users' data on government-owned servers and to have the key to unlock that data also located in China. Right. So basically this means that if Apple complied with the government's demands, Apple's Chinese customers' data would effectively be in the hands of the Chinese government.

So what does Apple do? Well, this is basically what I've been trying to answer for almost two years. How did Apple respond to this new law? So over the course of these years, my colleagues, Ray Zhang, Dai Wakabayashi, and I managed to obtain internal Apple documents. We spoke to 17 current and former Apple employees and also independent security experts.

And here's what we found. Apple essentially decides that it's willing to store the data in China. But in negotiations, Apple really tried to keep the encryption keys outside of the country, which would essentially protect the data and make it almost unusable for the Chinese government. Now, we don't know exactly what Apple was doing and saying to make its case to the Chinese government. And we don't know exactly how the Chinese government responded. But what we do know is that by 2018, those encryption keys did in fact end up in China,

along with the user data, in a Chinese-controlled data center. So, in effect, China won. Correct. Now, Apple has told us in response to our findings that it is doing everything it can to keep its customers' data safe. It also said that it's retained control of the encryption keys in China. And specifically, it said that it designed the security of its iCloud system, quote, in such a way that only Apple has control of the encryption keys, end quote. It didn't elaborate beyond that. But what we do know is that those encryption keys are stored on the Chinese data centers.

Now, we obtained internal documents that explain the design and security of the iCloud system, and we shared those documents and some of our findings with four independent security experts. And those experts said that because the encryption keys are stored in China, and not only in China, but on computers owned and run by the Chinese government, that makes it an impossible problem for Apple engineers to solve. You know, anything can be hacked. But when we're talking about the actual physical servers containing the data in the hands of a sophisticated hacker like the Chinese government, it becomes extremely difficult to protect that data. Do we know if China has actually accessed any user data that was made

more accessible, as you said, under this law? No, we don't know. What we do know is that the security experts said that Apple's compromises in China have made it nearly impossible for the company to stop the Chinese government from gaining access to the data. And we also know that this is not the only compromise Apple's making in China. What we found is that Apple is also becoming a tool of the Chinese government's vast censorship operation. And it all has to do with Apple's App Store. What do you mean? So we've known for a while that the Chinese government has asked Apple to take down apps. And we know that in some cases, Apple takes them down.

In some cases, Apple doesn't. But what we found is over the past several years, Apple has begun to build this sophisticated system inside of its company that is designed to take down apps proactively before the Chinese government even asks if it thinks the app could upset Chinese officials or run afoul of Chinese laws. And so as part of that system, Apple has created essentially a blacklist of terms that are banned in China. And these are things like independence for Tibet and Taiwan, the Chinese spiritual movement Falun Gong, the Dalai Lama, and the names of certain Chinese dissidents. And Apple

actually hires hundreds of its own app reviewers, and then it trains them on what topics to look for. And it also creates software that scans each app for the banned terms. And so as a result, Apple has removed tens of thousands of apps in China to appease Chinese authorities. And those include apps from foreign news outlets like the New York Times, gay dating apps, apps that get around the government's internet restrictions, and apps that helped pro-democracy protesters in Hong Kong organize. So Apple is proactively searching for topics in its own app store that the Chinese government deems off-limits and removing a bunch of them.

It's pretty extraordinary for an American company to play this role. It really is. And it essentially means that Apple, one of the most technologically advanced and richest companies in the world, is bringing to bear its technology and its resources to help the Chinese government censor the internet for Chinese citizens. What does Apple have to say about all of this? How does Apple defend its decision to comply with these pretty authoritarian demands from China? Well, in a statement Apple gave us in response to our story, they said, quote, these decisions are not always easy, and we may not agree with the laws that shape them, but our priority remains creating the best user experience without violating the rules

we are obligated to follow. Apple basically says that while it doesn't like these rules, they're the law, and Apple follows the law in the countries in which it does business. But obviously, this is an uncomfortable situation for Apple. From my American mindset, I believe strongly in freedoms. And in 2017, Tim Cook was asked about Apple's relationship with China. But I also know that each country in the world decides their laws and their regulations. And so your choice is, do you participate? Or do you stand on the sideline and yell at how things should be? And my own view very strongly is, you show up and you participate, you get in the arena, because nothing ever changes from the sideline.

And he basically argued that Chinese citizens and the world at large are better off with Apple in China. I had this 25-year view of China. So I've seen so much change in that quarter of a century. And to me, the arc of that is clear. Now, it doesn't mean that it's a straight line, but honestly speaking, in no country in the world is progress a straight line.

And his argument is that even though China is changing, Apple has more of a chance to influence the country if it stays in the country than if it leaves and is just on the sidelines. So given all of this, these compromises that Apple has felt compelled to make, is the company doing anything now to fundamentally change its reliance on China? Not fundamentally. Apple has begun to diversify in some very small ways. It is now assembling a small number of iPhones in India.

It's making AirPods in Vietnam, for instance. But for the most part, Apple still makes the vast majority of its devices in China. And the latest signs from its supplier report show that it's using an even higher percentage of suppliers in China than it did before. So, Jack, I'm thinking about this bet that you mentioned early on, the bet that Apple made on China, you know, that it would remain a hospitable place to do business and be a good partner in the long run. How should we think about that bet now? So from an economic standpoint, Apple's bet on China has been one of the biggest successes in modern business history. Apple is the most valuable company in the world, and it is the richest company in the world and the most profitable company in the world. But at the same time, Apple was in some ways making a bet that its entrance into China, its investment in China, would force China to open up and to liberalize and to reflect more of the values that Apple itself believes in. So at the outset, I think that Apple believed that it could change China. But two decades later, it seems to be clearer that China has instead changed Apple.

And I think that Apple's relationship with the Chinese government reflects a new reality in which the world's soon-to-be number one economy is run by an increasingly authoritarian government that is willing to squash pro-democracy protesters and also commit human rights abuses when it comes to the Uyghurs, which is the Muslim ethnic minority in the country. And because of the nature of the global economy, where China is one of the largest consumer markets, and more importantly, the home to the most sophisticated and largest supply chain in the world, it means that Western industry will now be grappling for years to come on how to deal

with this new China. on how to deal with this new China. Thank you very much, Jack. Thank you. We'll be right back. Here's what else you need tenor day. Benjamin Netanyahu's long and divisive time

as Prime Minister of Israel ended on Sunday when the country's parliament gave its support to a diverse coalition of his opponents. The margin of victory was razor thin, 60 to 59, with one lawmaker abstaining. Prime Minister-designate, please.

After the vote, supporters of Netanyahu repeatedly heckled his successor, Prime Minister-designate Naftali Bennett, who vowed in a speech to be a leader for all of Israel. Friends, even if you're not in the government, we will represent your voters and we will look after everyone. And America is back at the table. On Sunday, President Biden ended a summit of the Group of Seven, where he met with the heads of Canada, France, Germany, Italy, Japan, and the United Kingdom by declaring that the United States was eager to resume its role

as a leader in global affairs after four years of an America-first policy under Donald Trump. The lack of participation in the past and full engagement was noticed significantly, not only by the leaders of those countries, but by the people in the G7 countries. And America's back in the business of leading the world alongside nations who share our most deeply held values.

Today's episode was produced by Stella Tan, Austin Mitchell, and Soraya Shockley. That's it for The Daily. I'm Michael Bilbaro. See you tomorrow.